When preparing a bid for a particular contract, government contractors include a forecast of the direct cost for executing that contract, as well as an allocation of anticipated indirect costs.  

Indirect costs are business expenses that are not directly attributable to a particular contract. Examples include rent, property taxes, executive salaries, fringe benefits, and office supplies. Once indirect costs are identified, they must be allocated equitably across contracts based on the benefits they provide for each contract. This allocation is determined by using indirect rates.

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Indirect Cost Pools

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The first step to calculating indirect rates is to organize and group indirect costs into indirect cost pools, which are based on logical similarities and cost objectives. Examples of common cost pools are listed and described below.

• Fringe – Benefits, paid time off, payroll taxes, and related employee support. Fringe is typically applied to direct labor and indirect labor. Clear policies and accurate timekeeping keep this pool stable.
• Overhead – Costs that support contract performance (supervision, facilities, equipment, training). Many contractors use separate overhead pools (e.g., on‑site vs. off‑site, engineering vs. manufacturing) to avoid cross‑subsidizing unrelated work.
• G&A (General & Administrative) –Enterprise‑level costs to run the business (executive, finance, HR, legal).
• Material Handling / Subcontract Administration –Optional intermediate pools that recover the cost of buying, warehousing, and managing vendors. These protect the G&A rate when programs carry heavy material or subcontract content.
• B&P / IR&D – Bid & Proposal and Independent R&D are typically sub-sets of the G&A pool; and ensure proper allowability treatment and consistent policies.
• FCCM – Facilities Capital Cost of Money is a separately‑computed imputed cost tied to facilities investment.  This is often overlooked in proposals but valuable when applicable.
• Unallowables – Entertainment, alcohol, image advertising, and other unallowable costs must be excluded from all pools.

Accurate indirect cost pools will ensure compliance with government regulations and optimize profitability when bidding on new contracts.

Allocation Base

The indirect rate is calculated by dividing the indirect cost pool by the allocation base, which is the cost of the operations that the indirect cost pool supports.  For example, the base of overhead could be direct labor cost or direct labor plus fringe on direct labor. The base of material handling pool could be the cost of direct materials. The basis of G&A is almost all expenses other than G&A.

The two most common methods for determining the cost base are Total Cost Input (TCI) and Value-Added (VA).  

• TCI reflects all costs of the business unit for the period, such as direct labor, overhead, materials, subcontracts, ODCs. This is commonly used for labor-centric portfolios where materials and subcontracts do not play a major role.
• VA is the TCI minus material and subcontract costs.  This is a good fit for integrators/resellers or programs with significant exposure to materials and subcontracts.

Indirect Rates

Once the indirect rates are calculated, they can be used to calculate each contract’s share of indirect costs. The rates are applied as mark-ups on the contract’s direct expenses.

For example, under TCI direct labor is normally marked up by Labor x (1+Fringe rate) x (1+Overhead rate) x (1+G&Arate). This formula produces the wrap rate, which is used for bidding or cost-plus billing. Material, travel, and Other Direct Charges would usually be marked upby the G&A rate.